Insurance Float: Money Held Against a Future Claim

Float is the money an insurer holds between the premium arriving and the claim going out. Premium is paid in advance, claims are paid later, sometimes decades later, and float is what sits in the gap. The insurer holds it, invests it and is measured on it, and every rupee of it is owed forward rather than kept. Float is a measure of what has been promised, not of what has been earned.

The whole of it comes out of one gap in time. Money arrives at the start of a contract and leaves when a claim is made, and on a long contract the distance between those two moments does more to the economics of the business than anything in the pricing does.

The shape of this is familiar from ordinary life. A wedding hall takes the booking money in March for a dinner it will serve in December. For nine months that money is sitting in the hall bank account and the dinner is still owed. Nobody would call it earned. A school takes a year of fees in April and owes eleven months of teaching. An insurer is the same arrangement stretched a very long way: the money comes in now, the thing owed is a claim, and on cover written on a life the gap can run for thirty years instead of nine months.

What exactly is float, and when does it start and stop?

The statement line is a consequence and the two moments are the cause, so start with the two moments. An insurer takes premium now for cover that may be claimed on later. Between those two moments it is holding money that is going to leave, and it does not know exactly when it will leave or how much of it will go.

Float is money held against a claim nobody has made yet. Float starts when the premium reaches the insurer and ends when the last rupee owed on that cover has been paid out. On cover written for a stated period it is a short stretch. On cover written on a life it is most of a working lifetime.

Now the harder half, where the misreading is close to universal. Float is not revenue, it is not capital, and it is not a reserve of strength. Nothing has been earned by holding it, so it is not revenue. None of it belongs to the insurer, so it is not capital. And it is not a reserve of strength. The money is there because somebody has been promised something, and an obligation wearing the costume of a resource is still an obligation. An insurer with a very large float has made a very large number of promises. Whether it priced them well is a completely separate question and the size of the holding will not answer it.

Where does the gap come from, and is it only premium not yet used?

Most people picture one thing at this point: premium sitting in an account waiting to be needed. The picture is right, and it is about a quarter of the story. Four separate sources fill the same holding, and three of them have nothing to do with premium that has just arrived.

The first source is premium received in advance for cover that has not yet been provided. Cover for the coming twelve months paid for in one instalment in April means that by June a good part of what was paid still buys cover that has not happened, and that part is called unearned premiumPremium already received for a stretch of cover that has not been provided yet. Unearned premium is money in hand and cover still owed.. Unearned premium is the source most people picture first.

The second source is claims that have been reported and are not yet paid. Somebody has told the insurer that something happened, the file is open, the amount is being assessed, and until it is settled the money is still sitting with the insurer. Claims in that state are the outstanding claimsClaims the insurer already knows about and has not yet paid. The event has happened and been reported; the amount and the payment are still to come..

The third source is claims that have already happened and have not reached the insurer at all. An event occurred last month, nobody has filed anything yet, and the insurer is holding money against something it does not know about. The awkward phrase for this is incurred but not reportedSomething has gone wrong and word of it has not reached the insurer yet. There is nothing on file to count, so the amount gets estimated., and it is estimated rather than counted, because there is nothing to count.

The fourth source is the one that changes the scale of the whole thing. On a long contract, money has to be held now against a claim that is expected years from now. The fourth source is why a life insurer's holding is an order of magnitude larger than the holding of a book written for stated periods, and it is the reason the two kinds of insurer look nothing alike on a statement. Nothing has gone wrong and nothing is unusual. The contracts are simply long, so the money stays.

Net Premium: what gets taken out, and why does that subtraction matter?

An insurer does not always keep the whole of a risk it has written. Part of it can be handed to another insurer, with part of the premium sent along. Gross premium is what it took in before any of that happens. Net premium is what is left after the part handed on has gone, and net premium describes what the insurer actually holds and actually owes.

The part handed on is described as cededHanded over to a second insurer together with the slice of premium that pays for carrying it. Whatever goes out this way stops being part of what the first one keeps. to a reinsurerA second insurer standing behind the first, carrying a slice of the same risk and collecting a slice of the same premium for doing so. How the arrangement is struck is covered separately.. How that arrangement works, what it is bought for and what it costs is covered separately. The subtraction and its consequence are what matter here.

Here is the subtraction, and it is a supposition rather than a report. Chandrika Life Insurance Limited, an invented insurer writing cover on lives, took in total premium of Rs 15,600 crore in the stated year, made up of Rs 5,200 crore of new business premium and Rs 10,400 crore of renewal premium, so renewals ran at exactly twice new business. Now a supposition, kept labelled as one: say a tenth of the risk had been passed on. Rs 1,560 crore would go out of that Rs 15,600 crore and net premium would be Rs 14,040 crore. No ceded figure for this insurer is on record. The tenth is therefore supposed, and a supposed cession cannot carry the weight a recorded one would.

Now the rule that follows from the subtraction, and it is broken constantly. Gross goes with gross and net goes with net, on every line, in both directions. A claims figure taken after what the reinsurer will pay, sitting over a premium figure from before anything was ceded, describes nothing at all. The numerator has had a share taken out of it and the denominator has not, so the ratio comes out lower than the arrangement really is, and it comes out lower in a way that looks like good news. A mismatch of that kind is worth watching for. It does not produce an obviously silly number, it produces a slightly flattering one.

How big is the money held, and what is it measured against?

A rupee figure on its own says nothing about an insurer, so the division has to be run rather than a conclusion read off somewhere. Chandrika Life Insurance Limited is sitting on policyholder funds of Rs 72,000 crore, and its total premium for the stated year was Rs 15,600 crore. Rs 72,000 crore over Rs 15,600 crore is 4.6154. To two places it prints as 4.62. The insurer is holding about four and a half years of premium receipts.

The division is easy to read as a performance figure, and it is not one. Sit with what it actually measures. The ratio measures how long the average rupee stays before it goes out. The length of that stay is a property of the contracts the insurer has written, not of anything it did well or badly. Write long contracts and the number is large. Write contracts for stated periods and the number is small. A reader who treats a large one as an achievement has read a fact about the product as though it were a fact about the management.

The printed ratio needs one caution. The exact ratio is 4.6154 and it prints as 4.62 at two places. Rs 15,600 crore multiplied by 4.62 gives Rs 72,072 crore. Multiplied by 4.6154 it gives Rs 72,000 crore, the recorded figure. The longer figure is the one to multiply with, and then every number can be worked back from the numbers beside it.

The same holding gives a different answer against a different premium, so the base has to travel inside the sentence. On the supposed net premium of Rs 14,040 crore, the same Rs 72,000 crore reads 5.13 years rather than 4.62 years. Nothing about the insurer changed between those two readings. Not a rupee moved. The whole of the difference is the denominator. An unbased ratio on this subject is not a number anybody can carry anywhere.

Whose money is it while the insurer is holding it?

The whole subject turns on one relationship. Policyholder funds at Chandrika Life Insurance Limited come to Rs 72,000 crore. Its net worth, meaning the capital the insurer itself put up, is Rs 7,200 crore. Do the division: Rs 72,000 crore divided by Rs 7,200 crore lands on exactly 10.0 times. For every Rs 1.00/- of the insurer's own capital there is Rs 10.00/- of money that has been promised out to somebody else.

Turn that around and it lands harder. Take any Rs 100.00/- of the policyholder funds this insurer is holding. The capital standing behind that Rs 100.00/- is Rs 10.00/-. The rest of it is not a cushion, not a war chest and not spare capacity. The remainder is somebody's future claim, sitting in the insurer's account until the day it is asked for.

The obligation outlives the premium. The money is in the insurer's hands and the claim on it belongs to people who have not made it yet, most of whom will not make it for years and some of whom will never make it at all. An insurer described as a very large pool of money, with that fact left off, has been described as a custodian of other people's savings with a nameplate that reads insurer.

Vaidehi Asset Managers Limited, an invented manager of other people's money, makes the contrast sharp. The manager handles assets under management of Rs 1,80,000 crore in the stated year, far more than Chandrika Life Insurance is holding. The money belongs to the people who put it there and is accounted for as theirs, so that Rs 1,80,000 crore never lands on the manager's own statement of what it holds and what it owes. The insurer's money does land on its own statement, on both sides at once, as an asset it is holding and a liability it owes. The difference is not presentation. Looking after somebody's money and having promised somebody an outcome are two different businesses.

What may an insurer do with the money in the meantime?

The insurer invests it. Money held for years and left idle is money that will fall short of the obligation it is being held against, so leaving it alone is not the safe option a beginner assumes it is. But the choice of investment is not a matter of preference. Both constraints come out of the money being owed forward rather than out of anybody's appetite.

The first constraint is timing. The money has to be there on the dates the claims actually fall due. The investment therefore has to line up with when the money will be needed, a question about durationHow long money is expected to be held before it has to be paid out. Matching how long an investment runs against how long an obligation runs is covered separately. rather than about return. An insurer whose claims fall due next year and whose money is locked up for fifteen has not made a bold choice, it has made a mismatch.

The second constraint is what a loss would do. The obligation does not shrink when an investment does. If the money held falls in value, the promises it was held against are exactly the same size as they were the day before. The difference has to come out of the insurer's own capital, and that capital stands at Rs 10.00/- for every Rs 100.00/- of promise. There is not much room in that arrangement for a loss the capital could not absorb.

Which categories an insurer's money may actually be deployed in, and how any surplusWhat is left over after the value placed on the promises has been provided for. Who it is shared with, and in what proportions, is set by the regulator rather than chosen. arising is shared between policyholders and shareholders, are both set by the Insurance Regulatory and Development Authority of India (IRDAI) and published at irdai.gov.in, and both of them move.

Is float free, and what does holding it actually cost?

The commonest thing said about float is that it is money the insurer gets to use for nothing. The claim is true in exactly one case and false in the other, and telling them apart takes one subtraction rather than an opinion.

If premium came to more than claims and running costs put together, then somebody paid the insurer to look after the money, and holding it cost less than nothing. If premium fell short of the two of them, that shortfall is what the insurer handed over for the privilege, and the money was borrowed at a price rather than given away. Borrowing at a price is an entirely ordinary arrangement. The only mistake is calling it free.

Work it on this insurer's own numbers. Chandrika Life Insurance Limited took total premium of Rs 15,600 crore in the stated year. Claims were Rs 6,720 crore, or 43.08 per cent of total premium received. Expenses were Rs 2,496 crore, or 16.00 per cent of total premium received. Take both out: Rs 15,600 crore less Rs 6,720 crore less Rs 2,496 crore leaves Rs 6,384 crore, or 40.92 per cent of total premium received.

Now say immediately what that Rs 6,384 crore is not, before it starts travelling. It is not profit. The Rs 6,384 crore is also not the price of the float, in either direction. What had to be added to the reserve held against future claims is not on record, and it is therefore not in that subtraction. A life insurer takes premium this year against claims decades away, and the amount that had to be set aside this year for those claims is a real cost of the year that this arithmetic simply does not contain. How an insurer's whole earnings are put together, and how all three of the places its money comes from add up, is covered separately. The subtraction names the gap alone.

What makes float grow, and does a bigger float mean a stronger insurer?

Two very different things push the same number up, and in a single published figure they are indistinguishable.

The first is writing more business. More policies means more promises, so the obligation grows at the same moment the holding does. Notice what that means about quality. Nobody has yet seen how the claims on the newest promises come in, so those are the promises whose pricing has been tested least. A bigger holding built this way is a bigger book of untested pricing, and it is neither good news nor bad news until years have passed.

The second is claims taking longer to be settled. Money that has not gone out yet is money still in the account, so slower settlement lifts the holding without a single new policy being sold. Nothing has been earned, nothing has been won and nothing about the arrangement has improved. How long an insurer has to decide a claim and how long it has to pay one are both set by IRDAI at irdai.gov.in, and both move.

And there is a third case a reader rarely expects. A settled book pays out more than it takes in, so float shrinks when a book stops growing. An insurer that has stopped writing new business and is working through the promises it already made is described as being in run-offA book that is no longer being added to and is simply paying out what it already owes until the last obligation on it is discharged., and its holding falls steadily year after year. A falling holding can be an orderly wind down rather than a business in trouble, and the falling number by itself does not say which of the two it is.